You should consider "1031 Tax Deferred Like-Kind Exchanges."Let's face it... people have been trading with each other since the beginning of time. Most often these exchanges were hand to hand... a simultaneous trade or exchange. Real property was no exception. Trading property was similar to trading baseball cards or marbles. All you had to do was find someone who had what you wanted and persuade that person to trade for something you had.
There have always been simultaneous exchanges of many types of property, both real and personal. But there was no process for relinquishing the property and replacing it at a later date.
That all changed when the Starker family, a large landholder in the Northwest, kicked open the door for delayed tax-deferred exchanges of real estate. The Starker family traded a large area of timberland in the late 1960s but took so long to find a suitable replacement that it appealed to the IRS that a sale, on which taxes were due, had taken place. A lengthy appellate process ensued, with many strange twists and turns. Finally in 1979, the Ninth US Circuit Court of Appeals ruled in favor of the Starker family's "delayed exchange."
As a result of the Starker case, a prescribed method for executing delayed tax-deferred exchanges of investment properties was developed and made part of the IRS regulations in 1984. This section of the tax code, IRS 1031, clarified the rules and opened doors of opportunity for investors.
The IRS introduced regulations into 1031 that allowed the delayed exchange of investment property through the use of a qualified intermediary. These regulations created a clearly defined process for trading property without losing any equity to capital gains taxation.
The true power of exchanging is the ability to meet investment objectives without losing equity to taxation.
What is a 1031 Exchange
A 1031 Exchange is a transaction in which a taxpayer is allowed to sell one property and buy another without a tax consequence. This can be done through a simultaneous or delayed 1031 Exchange. The transaction is authorized by Section 1031 of the IRS Code. It is the best strategy for the deferral of capital gains tax that would ordinarily arise from the sale of real estate.
A successful exchange results in the taxpayer being able to utilize 100% of the proceeds from the sale of property to purchase a new property, thereby deferring capital gains taxes.
Real estate owners can accomplish virtually any objective with 1031 Exchanges, including greater leverage, diversification, improved cash flow, geographic relocation, and/or property consolidation.
An Underused Process
The 1031 process is not used as much as it could be. Why? Probably the biggest deterrent is that many real estate professionals don't know about or understand the process. At Heart Of Florida Realty... we do. A second deterrent may be that many investors don't realize that "Like-Kind" property is defined by its use in the hands of "its owner" not by "its type."
How does it work
A 1031 Exchange is usually a three-way delayed exchange, referred to as a "Starker Exchange," in which an intermediary is used to facilitate the transaction. There are four basic steps:
Seller arranges for sale of property and includes exchange language in contract.
At closing, sales proceeds go to a Qualified Intermediary for a 1031 Exchange.
Seller identifies potential exchange properties within 45 days of the closing.
Seller completes 1031 Exchange within 180 days of closing.
In a 1031 transaction, these steps can also occur simultaneously. Preferable, before you sell your property, you need to consider what type of replacement property will work best for you, and whether or not you want to own a whole or partial interest in a property. Increasingly, investors are choosing to purchase a partial Tenants In Common interest for several reasons.
The key is that exchanged property must be investment property. For example, an investment customer is free to acquire any of the following:
A single-family dwelling to be rented (with restricted personal use)
A condo to be rented (with restricted personal use)
An office building
A storefront
Pasture land to be leased to a rancher
Farmland to be leased to a farmer or tenant farmer
Raw land NOT to be used at all
The point is that residential and commercial property as well as raw land can be exchanged within the same transaction provided they are all investment properties.
Another use of the exchange process is to extend the holding period of the property to meet long-term capital gains requirements. In the rapidly changing real estate market, it is not unusual for waterfront property to go up in value quite rapidly.
Example:
Suppose an Heart Of Florida Realty professional helps a customer locate a building lot to hold for an undetermined period. In a very short time (less than a year) an offer is received that almost doubles the lot's purchase price, and the property is sold. Short-term capital gains taxes (15 to 39.6 percent) will be due on the profit from the sale. The seller can avoid a short-term gain by exchanging the lot for another property. In an exchange, not only are the capital gains tax deferred, but the holding period is tacked onto the new property.
Our goal is to help our customers achieve the most beneficial transactions in the management of growth investments.
Advantages of Undivided Tenants in Common Interest Ownership
It is often difficult in the short 45-day time frame to locate a property that has the right purchase price, debt ratio, and closing schedule to meet the 1031 exchange requirements-and then arrange any financing that may be necessary. Tenants in Common ownership interest has a number of advantages, such as:
Flexible size to match your needs
Pre-arranged financing
No management hassles
Potential for increased after-tax cash flow
Economies of sale
Can be identified and closed in a timely manner
Investment can often be diversified into more than one property
How will a Tenants In Common 1031 Exchange benefit Me
You may own management-intensive real estate. Although you are comfortable with real estate investments and have had good returns in the past, you do not like the daily headaches that can accompany real estate management. You are ready to give up the hassles of dealing with tenants, maintaining facilities, paying property taxes, etc. You would like to sell your property but are faced with onerous tax consequences on the sale. You'd rather enjoy the income from the property and let someone else manage it. With a TIC 1031 Exchange, you can do exactly that.
A TIC 1031 Exchange allows you to exchange your management-intensive property for an institutional-quality property with the potential to generate steady income, tax benefits and appreciation. With a TIC 1031 Exchange, you no longer have to feel burdened by your real estate. Through your management contract, a manager will be retained to manage the asset while you enjoy all the benefits of income property ownership-and freedom from management duties.
Your income from the replacement property may be higher than what you were receiving from the original property. You can earn substantial cash flow that may be up to 60% sheltered by the depreciation of your new basis in your TIC purchase.
No capital gains taxes may be due until the replacement property is eventually sold. If you shuffle off this mortal coil while owning a property, your heirs will receive a stepped up basis and the capital gains tax will be completely avoided.
The Qualified Intermediary
A benchmark requirement for the 1031 exchange process is that "qualified intermediaries" must be used to facilitate all transactions associated with an exchange. Qualified intermediaries are not allowed to act as agents to any party of an exchange. They must also be certain they have not acted as such for at least two years prior to the exchange (except to do other 1031 exchanges).
The intermediary works for both the real estate professional and his/her customer and is bound by US Treasury Regulations. The exchanger pays all intermediary fees from relinquished proceeds at closing. Often, interest earned by escrowed funds provides earnings for the exchanger that could exceed the entire cost of the exchange.
With few exceptions, the following are "disqualified parties" (disqualified from acting as an intermediary) by US Treasury Regulations:
Close family members, controlled corporations, partnerships or trusts in which the person desiring the exchange has a 10 percent or greater interest.
Agents of the investor such as:
Employee
Closing/escrow officer
Attorney or accountant
Investment banker/broker
Real estate salesperson/broker
Except for routine financial, title closing or trust services by institution, insurance and closing company.
How do I get started
Discuss your specific needs with your registered representative who will be happy to answer your questions and provide you with the information you need to consider a 1031 Exchange.
Just remember property that can be exchanged is real property or personal property such as aircraft, vessels, equipment or art. But the properties must be like kind, i.e., real estate for real estate... aircraft for aircraft. The investment requirement properties must be held for investment or in connection with a trade or business, but do not have to similar use, i.e., exchange raw land for an apartment building.
1031 Do's & Don'ts
DO advanced planning for the exchange. Talk to your accountant, attorney, broker, financial planner, lender and qualified intermediary.
DO NOT miss your identification and exchange deadlines. Failure to identify within the 45-day identification period or failure to acquire replacement property within the 180-day exchange period will disqualify the entire exchange. Reputable Intermediaries will not act on back-dated or late identifications.
DO keep in mind these three basic rules to qualify for complete tax deferral:
Receive only "like-kind" replacement property.
Use all proceeds from the relinquished property for purchasing the replacement property.
Make sure the debt on the replacement property is equal to or greater than the debt on the relinquished property. (Exception: a reduction in debt can be offset with additional cash; however a reduction in equity cannot be offset by increasing cash.)
DO NOTtry to do a 1031 exchange your self using your CPA or attorney to hold title or funds.IRS regulation requires a Qualified Intermediary to property complete an exchange.Call us for the name of one that operates in your area.
DOattempt to sell before you purchase. Occasionally exchanges find the ideal replacement property before a buyer is found for the relinquished property. If this situation occurs, a "reverse" exchange (buying before selling) may be necessary. Exchangers should be aware that reverse exchanges are considered a more aggressive exchange variation because no clear IRS guidelines exist.
DO NOTdissolve partnerships or change the manner of holding title during the exchange.A change in the Exchanger's legal relationship with the property may jeopardize the exchange.
1031 Terminology
Like-Kind Property Like-Kind refers to the type of property being exchanged. You can exchange any real estate investment for any other type of real estate investment - for example, vacant land can be exchanged for rental property. In most cases your personal residence is not Like-Kind investment property.
Exchanging Up To accomplish a fully tax-deferred exchange, the rule of thumb is "exchange even or up in value; exchange even or up in equity and in debt."
Boot To the extent that you do not exchange even or up in value and/or exchange even or up in equity and debt, you will have received non-qualifying property ("boot") in your exchange. If boot is received, tax is computed on the amount of gain on the sale or the amount of boot received… whichever is lower.
Typical Exchange Addendum Language for Sales Contracts Buyer hereby acknowledges that it is the intent of the Seller to effect an IRC Section 1031 tax deferred exchange which will not delay the closing or cause additional expenses to the Buyer. The Seller's rights under this agreement may be assigned to a Qualified Intermediary, named by Seller, for the purpose of completing such an exchange. Buyer agrees to cooperate with the Seller and the Qualified Intermediary in a manner necessary to complete the Exchange."
Sometimes people are comfortable where they are in their investment plan. However, someday you may be interested in seeing how income can be maximized and taxes decreased through the use of IRS 1031 Tax Deferred Exchanges. Print this information and please keep in your file for that time!
P.S. What do you have to loose? Absolutely nothing! To gain? FREE real estate services which equal money in your pocket. So call 877.303.SOLD or complete this form today and find out for yourself!
